When most investors think of cryptocurrencies, bitcoin is almost certainly the first asset that comes to mind. And one thing most people associate with bitcoin is its volatility.

Yet one corner of the crypto market that is becoming increasingly prominent and visible (if not always for the right reasons) is aimed precisely at having the opposite characteristic – stability.

As early as 2013, banks were preventing law-abiding citizens from interacting with cryptocurrency exchanges. This made buying and selling bitcoin difficult. So the crypto industry simply took banks out of the equation and replaced them with “stablecoins”. Simply put, a stablecoin is a dollar that lives on a blockchain.

A $ 1 stablecoin is worth $ 1, it’s that simple. It can be easily traded for volatile assets like bitcoin and ether. But it also offers crypto investors the opportunity to sit on the sidelines and hold a cash-like asset that is stable in value, at least in nominal terms (i.e. regardless of inflation). Sometimes stablecoins even pay interest.

This is the best example of unintended consequences I have ever seen. In public, banks would say how interesting they considered blockchain technology, supporting many technology incubators and hubs. Yet behind the scenes they were devoting even more resources to blocking transactions to and from crypto.

Banks were eager to reverse the crypto revolution. Instead, by requiring the creation of stable coins, they made the crypto stronger. The stablecoins market is now worth $ 134 billion and its existence has made crypto even more self-sufficient and less dependent on outsiders. It shows us how, in the years to come, it is the banks, and not the crypto, that will have to fight to survive.

Digital money

So what’s the problem ? It’s just a dollar on the blockchain. Don’t we already have digital money? Well, most people think they already have digital money because there is an app on their phone that connects to their bank, but it doesn’t. They just have a traditional bank deposit which can be administered electronically. The technology is better, but the money is the same. It’s on the bank’s balance sheet and, as we saw in 2008, that’s not always a good thing.

Stablecoins are a form of digital currency that completely knocks the bank out. Before stablecoins, the only way to transfer money was through an intermediary – a bank or a payment processor, such as Visa or PayPal. A stablecoin, however, is a digital form of cash, and it’s more mobile than a bank deposit.

You don’t need a bank account, just a digital wallet, which can be downloaded for free. It therefore has the potential to find its way to one of the approximately 7.5 billion mobile phones in the world. You can send that dollar around the world, exchange it for crypto, exchange it for another currency, or even purchase other assets, goods, and services. Better yet, it’s a bearer asset, which means it belongs to you, with no middleman in sight.

How stable coins work

Most stablecoins (the Dai – see sidebar – is an exception) are backed by an issuer that manages a pool of (preferably) low-risk assets, similar to a money market fund. These assets would include short-term US Treasuries, corporate bonds, money market instruments and cash. The issuer would benefit from any interest received, with an obligation to maintain the value of the assets so that the stablecoin is still worth $ 1.

The first successful stablecoin was issued by Tether (USDT). It has grown to $ 70 billion in circulation. It’s rife with controversy – the founders have “interesting” stories and some think asset support isn’t quite what it seems. He has also had numerous arguments with regulators and was recently fined $ 41 million by the US Commodity Futures Trading Commission for “not having enough currency reserves, regularly enough, to say that stablecoin eponymous was fully backed by US dollars “.

These questions about Tether paved the way for new rivals. The main challenger is Circle (USDC), which has reached $ 32 billion in the past year. It maintains better relations with regulators and is more transparent. As a result, it is gaining market share. There are many other issuers in the crypto industry, such as Binance, Paxos, and MakerDAO (see sidebar).

More importantly, there are many outside the industry who would like to be issuers as well, with the intention of mainstreaming digital bearer cash, such as Facebook’s Diem project, formerly known as Libra. The future of digital money is an almighty land grab, which is already well underway. Future players could one day hold more deposits than the banks themselves. No wonder regulators are paying attention.

What could go wrong?

A private company issuing a stablecoin guarantees that its digital dollars are fully backed by real dollars, but things can go wrong. Whether due to deception, incompetence, or financial collapse, a stablecoin will never have the guarantees of physical money, because it comes from the central bank. Here again, we have also seen money market funds “crack their mouths” in 2008: they could no longer guarantee that $ 1 invested corresponded to $ 1 in assets. Considering the size of these funds, their failure endangered the entire financial system and they were therefore bailed out.

The rate of growth of stablecoins is astronomical, with most of the growth occurring in the past year. According to Jon Cunliffe of the Bank of England, at $ 130 billion, stablecoins make up just over 5% of all cryptoassets. That’s more than doubled since 2020, when they were around 2% of the total. And although their use in crypto payment systems has so far been primarily aimed at payments in crypto markets, “there are signs that they are just starting to be used by players in the wholesale financial markets.” and big business, notes Cunliffe.

Central banks and regulators are watching this growth and may be concerned that it is getting out of hand. If, instead, central banks can launch their own central bank digital currencies (CBDCs), then, according to theory, there will be no need for stablecoins or other private sector solutions. Yet this line of thinking is incorrect.

The People’s Bank of China has taken the initiative to launch a digital yuan. It is ideal for snooping into the consumption habits of the population and potentially even blocking them from certain purchases. It would also allow the central bank to introduce negative rates by reducing your balance over time, which would certainly encourage more spending than saving. Some also see CBDCs as a form of geopolitical influence. For example, a digital yuan could find its way to all corners of the world and facilitate transactions away from home. This represents an opportunity for the yuan to catch up with the US dollar.

But there are risks. How embarrassing would it be for a central bank to see its CBDC hacked or facing a failure? Its credibility will never recover. On the other hand, if a private stablecoin (of sufficient scale) were to encounter a problem, central banks could heroically come to the rescue – just as they did with money market funds during the financial crisis.

Changing the way we interact with money

Currently, stablecoins are not based on their own blockchains, but on public blockchains, such as Ethereum, Stellar, Algorand, Solana or Tron. For example, Circle (USDC) is found on Ethereum. So, to send $ 100 of USDC, you have to pay a fee in ether (ETH), the cryptocurrency associated with the Ethereum blockchain, which is paid to Ethereum miners for processing the transaction.

These fees vary depending on the demand for blockchain space and can vary wildly. A year ago, these costs would have been negligible. Back in May, when crypto was all the rage, it reportedly cost over $ 50. Now it’s around $ 35. The problem with this system is that you are paying for the data rather than the value of the transaction. This means that a $ 1 transaction costs $ 35 to process, just as it would for $ 1 million. But many other competing blockchains will join this list over the next few years. If $ 35 is too high – which it clearly is – then another solution will come up that will offer a lower fee (or there will be a “layer 2” solution – one topic for another day – that will trade “off-chain. », More or less for free).

The underlying megatrend is that money is being digitized. Digital bearer money, which bypasses the current banking system, will change the way we interact with money. It could be a stablecoin, a social network, a payment company, a bank keen to keep up with technology, or even a central bank that cares little about a free society. There are endless possibilities on how this could evolve, but Stablecoins will only grow from here.

The main stablecoins

Tie (USDT): a de facto money market fund wrapped in a digital token pegged to the US dollar. It is closely linked to the crypto exchange Bitfinex, which has helped Tether’s token issue reach over $ 70 billion. The integrity of management and its assets has been scrutinized.

Circle (USDC): USDC is regulated in the United States and fully backed by US dollars, cash equivalents and short-term US Treasuries with $ 32 billion in circulation. As a result of Tether’s regulatory review, USDC exploded, increasing its market share of the stable coin market from 14.3% to 24.1%. The company behind Circle is considering listing in New York through a special purpose acquisition company (Spac) called Acquisition of Concord (NYSE: CND), with the support of asset managers Marshall Wace, Fidelity and Third Point, who funded the transaction to the tune of $ 415 million. Circle is expected to be valued at $ 4.5 billion and will trade with ticker CRCL, although a date has yet to be announced.

Dai: an Ethereum-based stablecoin pegged to the US dollar. MakerDAO allows users to generate Dai by depositing various other cryptocurrencies on the Maker protocol and borrowing against their value at varying interest rates. Alternatively, Dai can be purchased directly with fiat on digital asset exchanges.

Binance USD (BUSD): BUSD is another regulated stable coin backed by the US dollar. BUSD exists on three blockchains: Binance Chain, Binance Smart Chain and Ethereum. For each purchase of a BUSD, one US dollar is set aside. Paxos, the founder of the project, publishes monthly
reserve checks.

Charlie Morris is the founder and chief investment officer of ByteTree (bytetree.com).


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